When Tony Arrell first established Burgundy, he promised clients he would manage their money the same way he managed his own. The Burgundy investment philosophy has been and always will be to invest our clients’ capital in a select number of quality businesses that offer a margin of safety, trading at a 30% discount to our estimate of their intrinsic value. We believe that owning good businesses purchased at the right price and held over an extended period of time is the best way to compound our clients’ capital over time. This is the methodology that Burgundy has employed since the firm’s founding and is the investment philosophy espoused by Warren Buffett.
This past weekend, Mr. Buffett’s company, Berkshire Hathaway, published its 50th anniversary letter to shareholders. This is required reading at Burgundy. For those familiar with our firm, you know that we periodically produce thought pieces entitled The View from Burgundy. As I read Berkshire’s annual letter, I was reminded how easily one could mistake the content for passages from our Views over the years due to the striking similarities between Mr. Buffett’s advice and our approach as disciples of the quality-value investing philosophy.
A margin of safety emerges when a company’s undervaluation is due to factors outside its strong underlying fundamentals. It is often the result of a short-term misstep, for example, when the market punishes the stock price of a business because it misses a quarterly earnings estimate. Provided the underlying business is not threatened and we remain confident in its management, we will often step in and buy, believing, like Warren Buffett, “stock prices and intrinsic value almost invariably converge.”
Berkshire Hathaway has compounded capital so successfully because it has focused its investment in a limited number of businesses managed by highly capable managers. Similarly, the Burgundy equity mandates tend to be concentrated, typically owning 25-35 stock positions within each region of the world in which Burgundy invests. Just as Mr. Buffett purchases businesses for inclusion in the Berkshire Hathaway portfolio of companies, the shares of businesses we select for inclusion in a mandate must have strong (and understandable) balance sheets, be managed by capable and honest people and generate not only earnings but free cash flow as well.
Like Warren Buffett, we believe the risk of an investment should not be measured by its short-term volatility. Mr. Buffett notes that, “owning equities for a day or a week or a year is far riskier (in both nominal and purchasing power terms) than leaving funds in cash equivalents.” He encourages investors with material near-term cash needs to ensure this portion of their capital is not exposed to short-term equity market volatility. However, he goes on to note that for investors with a long-term time horizon, equities are the best method to protect capital against near constant wear of inflation on the purchasing power of their capital. We couldn’t agree more on both points.
Finally, Mr. Buffett cautions investors from attempting to time the market, saying, “market forecasters will fill your ears but never fill your wallet.” Words to live by.
The Berkshire Hathaway letters to shareholders are always brimming with practical and enduring advice, and the 50th anniversary letter does not disappoint in this regard. I encourage all investors to join us in reading the axioms that have led to one of the greatest investors of all time. In particular, I highlight pages 24-43: a look at the past, present and future of Berkshire Hathaway from the perspectives of both Warren Buffett and his partner/intellectual equal, Charlie Munger.